The Income Opportunity With Pipelines

At the Raptor, I educate the public on how to run an income centric portfolio that has the potential to beat the market with lowered volatility and allow for a greater than 4% withdrawal rate in retirement.  Central to this strategy is a mix of selling options for income, fixed income investing, and high yield investing such as in the REIT, BDC, and MLP spaces.  Today, I want to dig into the MLP space, as the industry is in transition.

A Master Limited Partnership (MLP) is a company, usually engaged in some type of natural resource exploitation, that has a tax exempt status if it distributes the vast majority of its operating cash flow to unit holders.  This exemption was carved out by Congress to encourage the financing of natural resource infrastructure.  Firms set up the structure with general and limited partners.The limited partner is the tax exempt entity and it often pays an Incentive Distribution Right (IDR) to the general partner.  This is a payment that grows as the distribution grows and serves as incentive for the general partner to grow the income stream of the limited partners.

Over time, these IDRs become punitive.  Several MLPs have eliminated them recently.  And quite a few have decided they are better off without their tax exempt status altogether and have had the general partner buy out the limited partners to operate as a conventional C corp.This has the added benefit of improving the credit profile of the company, thus lowering borrowing costs.  Cost of debt is often the largest expense for these companies so it can turn out that after reducing this and eliminating IDRs, the company can distribute more cash flow to shareholders even with the added tax burden.

I want to point out the opportunity in one of the best in class pipeline companies, Kinder Morgan (KMI).  KMI has eliminated its MLP limited partners and taken substantially all assets under the wing of the general partner.  The company has been shoring up its balance sheet and is transitioning into a mode of growing organically instead of through acquisition.  Distributions are expected to grow at 10% or greater per year for several years.

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